It's an understatement to say that 2020 has been a year like no other. The COVID-19 pandemic cost many people their jobs, and legislation designed to provide help also created new approaches for everything from Required Minimum Distributions (RMDs) to student loans—at least temporarily. Add in the uncertainty caused by market volatility and a presidential election, and it's clear that this year is unique.
That's why it's important to think about the moves you can make right now to remain aligned with your long-term financial strategy. Taxes should never be the sole driver of financial decisions, but they can play an important role in your overall financial health. Remember to check with your financial and tax advisors before you make any changes.
Here are four ideas to consider as we approach the end of this crazy year.
1. Review your income this year—and forecast for next year
Your income in a given year is one of the biggest drivers of how much federal income tax you're likely to pay. Remember, too, that different types of income are treated differently by the IRS. For instance, capital gains on the sale of investments is taxed at a different rate than traditional income. Before you decide to make any strategic moves to reduce your 2020 tax obligation, consider if it might be better to wait until next year. For example:
For those not yet retired
If you lost your job and were unemployed for a time this year, you may have more income next year that could put you in a higher tax bracket. If that's the case, you may want to consider whether it makes sense to recognize income from other sources while keeping your income in its current lower tax bracket so that all of it is taxed at a lower rate. If you spent time unemployed but are back at work now, and expect to earn less than you have in previous years, you may want to check your tax withholding from your paycheck to see if you should be withholding less. Remember, though, to change your withholding back at the start of 2021 if you hope to earn more next year.
If you plan on retiring in 2021 and think you may have lower income as a result, it may be smart to postpone any lump sum payments or bonuses, if possible, until a time when you're potentially in a lower tax bracket.
For retirees
The CARES Act brought one of the most significant legislative changes in 2020: the cut of RMDs during this year. If you decided not to take a RMD this year, your income may be lower compared to next year. Again, that makes it potentially a good time to realize other sources of income while staying in the same lower bracket this year.
Converting to a Roth IRA could be especially appealing this year as well. Normally, RMDs can't be converted to Roth IRAs. But because RMDs were waived, any amounts distributed from a traditional IRA may be converted to a Roth IRA; however, you still have to pay the taxes on the amount converted.
One big plus of rolling over 2020 distributions to a Roth IRA is lowered income tax liability years afterward because of reduced RMDs. In most cases, anything you withdraw from a Roth IRA will be income tax-free, though it's best to discuss further with your financial advisor.
2. Maximize your retirement savings
Regardless of whether you'll earn more or less next year, it's almost always a good idea to maximize your retirement savings. Recent laws have changed some of the traditional thinking, making it smart to double-check to make sure you're taking full advantage of the options available to you.
